With the retail fuel prices scaling new highs day by day, the oil marketing companies (OMC) are witnessing their auto fuel gross marketing margins rising back to FY21 average levels, the highest annual average margins ever.
The global crude oil prices have rallied sharply and are above $70 per barrel. Analysts expect auto fuel demand to bounce back in FY22, resulting in a further rise of gross marketing margins and recovery in gross refining margins (GRMs) for the OMCs going ahead.
"While diesel is almost back at FY21 average levels, petrol lags at almost 1/3rd of that level. However, the sharp increase in petrol retail prices has made ethanol blending very profitable, with ethanol adding over Rs 0.95/ltr to petrol's overall margins currently, though petrol continues to lag even after this huge contribution," Antique Stock Broking said in a report.
While FY21 witnessed historic high auto fuel margins, the brokerage house believes it is likely to rise further over the next few years driven by the continuous investments by OMCs in marketing. It expects margins to rise by Rs 0.2/ltr every year over the next 3 years.
Further, marketing margins have recorded steady growth post-deregulation. Though OMCs have been perceived to be not entirely market-driven most of the time, they have managed to keep retail prices moving and have delivered robust margin improvement.
"We believe disinvestment of BPCL is likely to rid of any residual influence the government is likely to have on OMCs, which would be a significant positive and is likely to drive a rerating," the report said.
Further, it expects a recovery in refining margins (GRMs) to sustainable levels of at least $4/bbl, which is about $1/bbl above-average global cash cost levels driven by a sharp recovery in global oil product demand in H2CY21 by over 4 million bpd along with the permanent shutdown of refining capacity over and above the already announced 2.3 million bpd.
Additionally, it is expected that new City Gas Distribution (CGD) geographical areas and likely LPG deregulation will create significant value for OMCs.
“While the committed work programme in the CGD bids provides enough "visibility to warrant an option value, we believe LPG deregulation is imminent given the sharp retail price revision over the last 8 months eliminating subsidy on the product. We are building in 20-50 percent of potential value as option value, contributing 2-5 percent to OMCs valuation," Antique Broking said.
Despite the recent rally in OMCs, the brokerage said that the valuations remain attractive at EV/ EBITDA of 4.6-5.5x FY23E, net of investments, with IOCL and HPCL at 4.6-4.7x and BPCL at 5.5x. It assumes coverage with a Buy on all three OMCs.
HPCL is its top pick in the space, given the valuations as well as the highest target price sensitivity to likely improvement in both GRMs and marketing margins.